ECON 3 Lecture Notes - Lecture 5: Real Interest Rate, Marginal Cost, Marginal Product
Document Summary
A firm is deciding whether to buy a machine. Costs ,000 - call this the price of capital pk. Depreciates 10%/yr, so it requires ,000 of repairs each year to stay productive. (depreciation rate = 0. 1) The firm can borrow or lend at a real interest rate of r = 5%. We need to convert the cost to an annual basis to compare to its annual benefit. Real interest rate of r = 0. 05 (5%) General expression for user cost or rental cost is the following: A profit-maximizing firm should buy k up to the point where: (1-t) (pf) (mpk) = (pk)(r + ) {marginal benefit} {user cost} t = tax rate. Note: an increase in pk, r or depreciation rate raises the user cost of capital. We assume declining mpk, so ^ k -> vmpk. Suppose we start with (1-t) x pf x mpk > pk(r + ).
